Goldman Sachs: Risk assets are moving towards the "Goldilocks" ideal state

Goldman Sachs believes that the "Goldilocks" market is making a comeback, driven by both dovish expectations and a reduction in risks. Goldman Sachs advises investors to adopt options hedging strategies and emphasizes the importance of regional and style diversification during the summer.

According to news from the Wind Trading Desk, Goldman Sachs published a research report on Monday indicating that there has been a significant positive change in the market environment, driven by three core factors:

• Enhanced dovish expectations from the Federal Reserve: Market expectations for a dovish stance from the Federal Reserve have significantly increased. Goldman Sachs economists have brought forward their forecast for the next rate cut to September and lowered their terminal rate forecast to a range of 3-3.25%.

• De-escalation of geopolitical risks: The easing of tensions in the Middle East has reduced the geopolitical risk premium in the market.

• Progress in trade negotiations: Positive developments in U.S. trade negotiations, including the cancellation of the "section 899" clause, have supported growth prospects.

These factors collectively create a "Goldilocks" macro backdrop—neither overheating in the economy nor excessively high inflation, sufficient for the central bank to maintain an accommodative stance. In this environment, despite last week's macro data on U.S. personal spending, new home sales, and consumer confidence index all falling short of market expectations, the market's "global growth" factor has actually improved.

This indicates that the market places greater importance on the benefits brought by accommodative expectations, thereby driving a rebound in risk appetite—the risk appetite indicator has rebounded to 0.3, successfully pushing the U.S. stock market to new historical highs. Goldman Sachs has brought forward its next rate cut expectation to September and lowered its terminal rate forecast to 3-3.25%. However, Thursday's labor market data will be a key test for maintaining positive momentum.

Macroeconomic Risks Diminish, Earnings Expectations Improve

As concerns about macroeconomic risks diminish, investors' attention is increasingly shifting towards corporate fundamentals.

The research report points out a positive signal: earnings expectations are improving. Over the past month, consensus revisions for earnings per share (EPS) in most regions have become less pessimistic, with EPS revisions in the U.S. stock market even turning to positive growth.

Therefore, the upcoming second-quarter earnings season will be crucial for validating market optimism. Goldman Sachs' U.S. strategists note that the expectations threshold for this quarter's earnings reports is relatively low.

The market generally expects second-quarter EPS growth of 4%, significantly lower than the 12% in the first quarter. This creates conditions for companies to "easily" exceed expectations.

Meanwhile, the implied correlation of stocks has been declining since April, reflecting investors' expectations that individual stock performance during the earnings season will diverge, while macro risks are fading.

Specifically, the implied correlation of the S&P 500 Index and the Nasdaq 100 Index has fallen to the 17th and 10th percentiles since 2020, respectively, in stark contrast to the European STOXX 50 Index.

Focus on Risk Hedging, Labor Data as Key Risk Point

Despite the optimistic market sentiment, it is not without concerns. The labor market data to be released this Thursday is crucial for maintaining the current positive momentum Goldman Sachs economists expect non-farm payrolls to be 85,000, lower than the market consensus of 113,000. If the data falls short of expectations, it may further strengthen the market's interest rate cut expectations.

Goldman Sachs considering that the market is pricing in a more ideal "golden girl" environment, suggests investors adopt options hedging strategies, emphasizing the need to focus on regional and style diversification during the summer period. Specific hedging recommendations include:

• Hedging against stagflation shocks: It is recommended to buy put options on USD high yield bonds (USD HY) or credit default swaps (CDS).

• Hedging against a re-inflation rebound: It is recommended to buy payer positions in interest rate swaps.

• Other recommendations: Hedge against position reversal risks through call options on the European banking sector and emerging market collar options